Software package pricing to fall

Companies investing in new systems have grown accustomed to the fact that hardware prices keep dropping from year to year, while the prices for packaged software, at best, stay the same. As a result, software has been growing as a percent of corporate IT spending.

But maybe that's about to change. Meta Group is now predicting that, over the next 3-5 years, packaged software pricing will decrease for the first time in over a decade. The reasons? Meta points to the ability of companies to more easily develop (or contract to develop) their own software on top of infrastructure services from IBM, Microsoft, SAP, and Oracle; the alternative of open source software; the growth of third-party application service providers (ASPs), and the trend to cheaper offshore labor. (Each of these reasons is a subject onto itself, which I won't develop further for now.)

If Meta is correct, the trend toward vendor consolidation will continue as it simply becomes more difficult for vendors of packaged software to make money in this market. In fact, Meta predicts that the number of traditional software vendors will drop 35% by 2008, and another 15% by 2010.

"This shift has so many implications that it would be hard to overstate. We are not only seeing consolidation trends, but more importantly, we are beginning to see a burgeoning new software industry being germinated by IBM, SAP, and Microsoft that is cutting a swath through every layer of traditional IT. These events are redefining the economics of the technology market in some fundamental ways," said META Group Research Director, Dale Kutnick. "We are already seeing the major technology vendors positioning themselves and investing more aggressively in infrastructure and Web services, where they believe their products can support this more stable model, versus battling it out in the old packaged application software market. Many vendors are terrified and questioning what to do and where to go next."

All of this is good news for software buyers, who are finally in a stronger position at the negotiating table. Kutnick continues:

Traditionally, customers were beholden to their software vendors for the long term simply because alternatives were costly; ongoing maintenance and service support nearly guaranteed ongoing commitment to legacy vendor partners. This vendor "gravy train" is now in jeopardy due to emerging alternatives. As software becomes more interoperable and structured in a more flexible nature, customers can realistically threaten to bring their business elsewhere or explore to low-cost offshore alternatives if they are unhappy with their current vendor.

Meta's predictions match what I am seeing in deals lately. Vendors of packaged applications seem more reasonable in their pricing expectations, and more flexible in how they structure deals. Although there are fewer vendors than there were five years ago, there are still enough vendors to make every deal competitive, especially in the mid-market, and vendors are hungry. Furthermore, even though there is an overall trend to vendor consolidation, new vendors keep appearing, often with specific niche solutions in certain vertical industries that keep challenging the attempts of established vendor to hold the line on pricing.

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